One of the oldest forms of gambling is betting on the outcome of a race. Before the race, a player places a bet on a horse. The player can place a bet to win (finish first), place (finish first or second) or show (finish first, second or third). A bet to win pays out more than a bet to place or show. An exacta is a bet on the first and second horses to finish the race; the player wins only if the 2 horses picked finish in the exact order specified. Other bets involve selecting the winner of 2 or more consecutive races. The minimum bet for a horse in Canada is usually $2. If the odds are 2 to 1, the winning bettor gets back roughly $6 (a win of $4, plus the original bet of $2). The payout, however, is based on the odds at the beginning of the race, not the odds posted in the Daily Racing Form. If too many people bet on a particular horse, the payout drops.

As stated above in “How the House Edge Works”, the posted odds usually overestimate a horse’s chances of winning, which results in the payout odds being less than the true odds against a horse winning. By overestimating every horse’s chance of winning, the bookie or racetrack underpays the bettor for a win.

Odds in horse racing rely directly or the behaviour of the betting public. The parimutuel method makes the payoff odds inversely proportional to the amount of money wagered on each horse. The track operators remove about 17% of the amount bet on each race and the rest of the money is distributed among the bettors who selected winning horses (Stern, 1998). It takes quite a while for the track to work out exactly how much each winner gets for his/her win.

The art of handicapping is the process by which a horse race bettor tries to figure out the true odds of a horse and identity horses that are undervalued in the posted odds. A horse’s past performance is usually given in the Daily Racing Form, available for a small fee at the racetrack. However, a horse’s ability is factored into the payout, so the only way to win money is to predict the outcome better than the odds makers and better than most of the betting public. For example, if a lot of people bet on popular horse because it is the offspring of a particularly successful horse, its posted odds may be different from its true odds.

There are an enormous number of variables that can be used to predict the outcome of a race. These include a horse’s past performance (wins vs. losses), its pedigree, its class, its adjusted speed in previous races, its temperament, its breeder, its trainer, the track conditions, the weather and the mix of other horses in the field.

Andrew Beyer (1983), a racing columnist for the Washington Post and the author of four books on how to pick winners in horse racing, bases most of his betting decisions on his studies of the speed of horses. Before he made his method public, the speed factor had been underused by bettors because only raw times (the time it took to complete the race) were available, and these times did not accurately reflect what horses would do on tracks of different lengths and under different conditions. Beyer’s method produced a measure that factored in the distance and condition of the track. Once these speed figures became widely known, they became one of the variables on which bettors based their choices and thus were taken into account in the odds (Greenhouse, 1998, pp. 48–51; see also Beyer, 1983). Thus speed handicapping is no longer a reliable method of earning money because the market efficiently incorporates this information into the payout odds.

The payout for a horse is inversely proportional to the value of bets placed on a particular horse. Players base their bets on their estimate of the horse’s ability from its past performance. Consequently the only way a player can make money in the long term is by knowing something that the other players do not know. According to Beyers (1983), trip handicapping is a means of acquiring information that is not commonly available. It involves a detailed study of the track, the specifics of past races, and the other horses, and is used to adjust the interpretation of the speed figures. Suppose that in its last race horse A ran on the outside of the track, which is the longest distance around, or was “boxed in,” that is, blocked by other horses, during the first quarter of the race but overcame these problems and still came in fourth. This horse might be posted at 10 to 1, but its true odds might be closer to 8 to 1. In contrast, suppose that in its last race, horse B started in the first position and had a very easy win because weaker horses blocked the other strong contenders. In the current race, horse B may be the favourite among average players, but to the trip handicapper, horse A would represent more of an opportunity because it is undervalued and horse B may be overvalued.

By searching for this trip-related information, a player can theoretically get an advantage over other players. Like card counting, such a system takes a great deal of time and patience as well as a suppression of the excitement and gut instinct that gamblers tend to feel when anticipating a win.

Although sports games are games of skill, betting on their outcome involves a lot of chance. Sports betting is quite similar to betting on the horses: the gambler studies the past performance of the teams and notes the current health of the players to determine which team has the upper hand. Rather than by odds, betting on sports teams is most often equalized by an estimate of how much a team will win by; this is called the point spread. Suppose the Toronto Maple Leafs are playing against the Montreal Canadiens and the Canadiens have won a lot more games than the Leafs. Bookies might estimate that the Canadiens will win by 3 goals. In such a case, a bet on the Canadiens only wins if the Canadiens win by 3 goals or more, but a bet on the Leafs wins if the Canadiens win by 2 goals or less, that is, the Leafs “cover the spread.” If done correctly, the point spread has the effect of making the outcome of the bet essentially random. Some sporting events are wagered in the same manner as horse races. Other games, such as baseball, use a system called the money line instead of a point spread, but the goal is essentially the same: to balance the betting action on both sides of the game.

As a general rule, in most point-spread bets the player must wager $110 to win $100. The difference between the bet and payout ($10) is the vigorish or house edge (4.55%), which results in a payback percentage of 95.4%.

Because the point spread is computed subjectively, it is never perfect and therefore the bettor has a chance of winning if he/she can figure out the true odds more accurately than the bookies and the general public. There are numerous methods a player can use to compute the most likely winner. Sports statistics are available in newspapers and online.

The only way for a bettor to beat the odds is to find a factor that has been undervalued by the sports bookie or the betting public. Unfortunately, this quest runs up against market efficiency. Any knowledge about a team that is not insider knowledge, that the player could use to increase his/her chance of winning, would also be known to others and would be taken into account in the final point spread (Stern, 1998). Market efficiency is never perfect, however, and as long as enough non-professional players make bets on their favourite teams, there will be opportunities for professional players.

Technically, the stock, options, currency and commodities markets are not games. Stocks and options are a means by which companies raise money to finance their operations. In return for purchasing a company’s stock, the investor receives a percentage of the company’s profit in the form of dividends, as well as capital gains on his/her investment. Commodities are simply raw products, such as wheat, coffee, nickel and electricity, traded on regulated exchanges. Currencies likewise are traded on regulated exchanges. A diversified portfolio of stock investments is usually a relatively safe investment with a positive, long-term expected return.

In the past few years, however, the markets have appeared to become more and more about gambling and less and less about investment. Investors try to buy stocks that are undervalued or buy new unknown stocks with potential and then sell them for a profit.

There is no real house edge in the market, but the investor has to pay a commission to his broker for each purchase. The commission varies depending on the size of the purchase, the account value, the customer and the volume of the customer’s transactions (Schneider, 1997, personal communications). (See note 1 below) Small investors are often working against a fairly large commission. But traders who can deal in large volumes can reduce the commission to a very small percentage. Long-term investors can usually expect a positive return of as much as 10% per year (a payback of 110%) or more. Due to the cost of commissions, short-term investors on the other hand are often working against a negative return.

Since gamblers want the big payoff, they are likely to purchase more speculative investments, such as small or new companies or commodity futures. An investment in a new company is risky, but has the potential for extraordinary growth.

“Going long” means buying and holding a stock. In addition to buying a stock, an investor can buy an option to purchase a stock on a future date, in a few months, for example, at an agreed price. If in the intervening time the stock goes up in value, the investor can exercise the option and buy the stock at the agreed price to make a profit. If the stock price goes down, the investor loses only the price of the option. Buying options is cheaper and less risky than buying the actual stock, but the cost of the option somewhat cuts into the profit margin.

“Selling short” is selling, at an agreed price, a stock that the seller does not actually own (hence the seller is selling “short”). At some point, the seller has to make good on the investment, actually buy the stock, and hand it over to the purchaser. If the value of the stock goes down before the short-seller must acquire it to give to the purchaser, the short-seller makes money because the stock is now worth less than the amount he/she sold it for. Suppose a stock is currently listed at $110, and Sam arranges to sell it to Joe for $100, but Sam does not actually own that stock. A week later the stock’s price goes down to $50; Sam buys the stock on the open market and hands it over to Joe. The extra $50 Joe pays is Sam’s profit. If Sam guesses wrong, however, he could lose a potentially unlimited amount of money because there is no limit on how much a stock can increase. As a precaution, before short-selling the stock to Joe, Sam could purchase an option to buy the same stock at a reasonable price. This decreases his profit a little (by the cost of the option), but it “hedges his bet” to avoid possible ruin.

In the commodity or currency markets, an investor buys or sells futures on a commodity or a foreign currency. “Futures” are contracts to purchase a commodity at an agreed price on a specific date in the future. An investor buying futures will make money if the price of the commodity increases and lose if the price of the commodity decreases. An investor can also sell commodities “short,” in which case he/she will make money if the price declines.

Recent advances in technology now make it possible for small investors to buy and sell stocks, bonds and commodities instantly over the Internet. Previously, such instant trading was available only to relatively large investors over the phone. Consequently, a new breed of market gamblers called day traders has emerged. These day traders try to emulate the traders on the floors of the exchanges who are typically in and out of their market positions in the course of a trading day. They attempt to make money by capitalizing on the transitory ups and downs of a stock.

Day traders make buy and sell decisions based on the movement of a stock’s price, looking for a larger-than-average spread between the bid price (the price at which a broker will buy a stock for a client) and the ask price (the price at which the broker will sell), or they follow the value of a stock and try to predict where the stock’s price will go on a moment-by-moment basis. To a large extent this sort of prediction is based on hunches, but experienced traders are supposedly able to “read” the market (predict its behaviour).

Another day-trading strategy is to take both long and short positions on the same stock to hedge the bet. If the stock goes up, the day trader cancels the short position in the hopes that the long position will make money, and vice-versa. Profits come from short-term fluctuations in the stock’s price—often day traders will hold a stock for only a few minutes. The long-term value of a stock has no place in the day trader’s analysis, and it is quite common for a trader to know nothing more about the company than its stock exchange symbol. Stocks prices can vary greatly over the course of a single day, and theoretically an investor could make a large amount of money buying at the dips and selling at the peaks. Some day traders will keep track of who is buying and selling stock and copy their lead. The problem for the small investor is that the big investment houses, who buy and sell stocks in huge blocks, have the ability to actually move the market. If they buy a stock, the price goes up because the supply has decreased. If the market, like a pack of sheep, follows the leader, a single large purchase could trigger a buying frenzy. Small investors can not move the market; they become the sheep that allow the large investors to make money.

Part of the attraction of day trading is the adrenaline rush. It can be all consuming; during the hours when the market is open, a day trader may feel he/she cannot afford to leave the computer.

Is it possible to make money as a day trader? According to the U.S. Security and Exchange Commission (2005), most day traders will lose some or all of their capital in the first few months, and many will never go on to make a profit. Day trading is at best a zero-sum game in which one investor’s loss is another’s gain. When the commission is factored in, however, day traders are in fact playing against a payback percentage of less than 100%. There are  individual traders who mostly win, and others who mostly lose. It is an open question as to how much of the difference is due to chance and how much to skill. Many investment advisors suggest that the best strategy for “winning” on the stock market is to buy and hold for the long term. In a study of 35,000 customer accounts of a large U.S. brokerage, researchers from the University of California found that on average male account holders traded 45% more often than females, but that the men’s average risk-adjusted returns were 1.4% less (Barber & Odean, 2001).

1) Jim Schneider was interviewed by the first author in 1997. He has worked in the stock market and at one point ran a brokerage firm. He provided a great deal of the information on the topic of stock market gambling that is presented in this section.

The conventional theory of the stock market, the efficient market model, holds that all available information about a stock is factored into its price. Companies release annual reports that are available from a stockbroker. This information can be used to evaluate the potential of a company. For example, a company might have a very favourable price-to-earnings ratio. If the market is efficient, this news is quickly factored into the value of its stock (Peterson, 1999). By the time the individual investor hears about the information, the potential advantage of the purchase has been washed into the market.

According to this view, price fluctuations are merely a “random walk.” The random walk theory says that stock values follow a wholly random path; the chance of a stock’s price going up is the same as it is for going down. Over a period of time, however, prices maintain an upward trend. While the market often behaves as if stock prices were on a random walk (Heakal, 2002), we believe that the market is more accurately described as a complex and chaotic system (Gleick, 1987). Complex systems are not in fact random, but are so complex that they appear to be random.

The efficient market hypothesis is only partly true; not all information is known or used properly by all investors. In addition, every investor does not learn about new information at the same time. The first people to learn new information will benefit more than others. There are opportunities, but finding them takes research. In addition, investors do not always act rationally, but might buy a stock because it has already skyrocketed in price or sell in a panic because of a temporary dip in the price.  Making a profit on the stock market is similar to poker or sports betting; the successful player has to outthink the rest of the market by finding stocks or commodities that are undervalued or have potential for growth. In recent years much effort has gone into developing models which demonstrate that market values are influenced by the psychology of investors—in particular a tendency toward herd behaviour (Peterson, 1999). Proponents of the behavioural approach base their investment decisions on an analysis of historical patterns of investment behaviour, on the assumption that there is enough regularity in the behaviour of investors to allow them to make money.

 Back to Games and Systems